Manulife: Undervalued With Massive Capital Returns (NYSE:MFC)

Asset-light companies such as those in the insurance industry can be great diversifiers for portfolios that are heavy in capital-intensive industries like industrials and manufacturing. That’s because unlike the latter, insurance companies don’t have high fixed costs that can be a drag when economic activity slows down, and with higher margins, more cash flows can be directed toward shareholder returns.

This brings me to Manulife Financial (NYSE:MFC), which I last covered here back in December 2022 with a ‘Buy’ rating, noting its robust operating fundamentals and promising exposure to emerging markets.

The company has executed well since, and it appears that the market has agreed with my investment thesis, as MFC has given shareholders a 27% total return since my last piece, besting the 22% rise in the S&P 500 (SPY) over the same timeframe. In this article, I revisit the stock and discuss what makes MFC a continued good value stock to Buy in this frothy market, so let’s get started!

Why MFC?

Manulife Financial is a Canadian insurance giant that provides insurance, annuities, and asset management solutions to individuals and organizations in Canada, the U.S., and Asia.

Like most of its financial peers, MFC has given respectable returns to shareholders over the past 10 years, with most of it in dividends that investors can use to reinvest into the stock or to pay for living expenses. As shown below, the investor who put $10,000 into MFC in 2014 would have realized a 72% return with a $17,150 value with reinvested dividends. While that’s not a great return, it’s not bad either, especially for a diversified portfolio that balances growth with income.

Moreover, I believe the next 10 years may look more different for MFC compared to the previous 10. That’s because, for one thing, interest rates today are now much higher than where they were during the past 10 years when central banks largely adopted a ZIRP policy. As investors in the industry know, higher interest rates benefit insurance companies since they can invest unused policy premiums, otherwise known as the insurance float, at higher returns on capital.

Plus, MFC’s transformation in recent years toward a multi-geography approach has enabled it to capture growth opportunities in emerging markets in Asia. This is reflected by the following chart, which shows 23% sales growth in MFC’s largest segment, APE (annual premium equivalent), over the past 12 reported months to C$1.66 billion. Much of that growth was driven by MFC’s home Canadian market (51% YoY) and by Asia, which saw 23% YoY growth.

Importantly, MFC’s growth is flowing to the bottom line, as core earnings per share grew at a faster pace at 35% YoY during the third quarter. Also encouraging, MFC is delivering a core ROE of 16.8%, which is higher than its benchmark target of 15%. As shown below, MFC scores an A+ grade for Profitability relative to the Financials sector, due to its sector-leading margins and returns on capital.

Looking ahead to Q4 results and beyond, MFC has the potential to extend its momentum around growth and profitability, as it increasingly adopts digitalization when it comes to new customer applications and engagement. It also has growth opportunities in Asia and less risk-intensive segments of its business as it seeks to continually transform itself. This is reflected by the following statement in the most recent Morningstar analyst report:

The company’s strategy is to transform itself to improve its growth potential and reduce the overall risk profile of its businesses. Management aims to increase the contribution of high-potential businesses (Asia, investment management, behavioral insurance) to 75% and reduce the combined contributions from long-term care insurance and variable annuities businesses to less than 15% of core earnings by 2025 through organic optimization.

Manulife’s Asia business stretches across the continent as the firm provides insurance and wealth products in Japan, Hong Kong, Singapore, mainland China, and other Southeast Asian countries. The Asia business has been a big focus for management in recent years as it expects strong growth in this segment on the back of secular economic trends such as the emergence of the middle class, relatively low insurance penetration, and a large mortality protection gap in these countries. We also like management’s focus on controlling expenses, with the company achieving its $1 billion target of expense savings ahead of schedule.

Moreover, global wealth and asset management still represents plenty of greenfield opportunity for MFC, as it generated C$5.8 billion worth of asset net inflows during the first eleven months of 2023. There is potential for more net inflows in 2024, as supported by a record amount of capital sitting on the sidelines as investors await more clarity around the direction of interest rates.

Meanwhile, MFC enjoys a strong balance sheet with an ‘A’ credit rating from S&P. This is supported by a strong LICAT ratio of 137%, which remains largely unchanged from the 136% in December 2022 when I last visited the stock. This ratio also sits well above the 90% regulatory limit, thereby providing plenty of capital buffer to meet potential adversity.

Risks to MFC include the potential for lower interest rates, which would pressure its earnings on investments. Also, as with any insurance company, a higher-than-expected mortality rate would increase payouts and thereby put pressure on its bottom line. Plus, a tough macroeconomic environment could result in net outflows and underperformance in MFC’s global wealth and asset management business.

Turning to capital returns, MFC currently yields a respectable 5.0% and the dividend is well-covered by a 41% payout ratio. It also comes with a 5-year dividend CAGR of 8.8% and 10 years of consecutive growth (dividend growth and consistency is measured by U.S. dollars, and could be different based on Canadian currency). Additionally, MFC repurchased $1.3 billion of its stock at attractive valuations in the first nine months of last year. As shown below, MFC has reduced its outstanding share count by 6.2% since January 2022 from 1.94 billion to 1.82 billion shares.

Lastly, I continue to see value in MFC at the current price of $21.41 (as of writing) with a forward PE of 8.5, sitting below its normal PE of 10.5 over the past 10 years. I believe the normal PE is a reasonable baseline assumption, considering that insurance companies like MFC benefit from the current high interest rates. This is supported by the fact that 49% of MFC’s invested assets are in government and corporate bonds, as shown below.

At the current valuation, MFC is getting an attractive 11.8% earnings yield for every dollar spent on share buybacks. MFC is also priced for little or no growth, which should not be the case, considering its excess cash flows which can be spent on buybacks and analyst estimates for 7.5% annual EPS growth over the next 2 years. I believe a 5-8% forward EPS growth rate is reasonable, considering the aforementioned high interest rate environment, underlying growth drivers in Asia and global wealth management, as well as capital returns through share buybacks at the current attractive earnings yield.

As shown below, Seeking Alpha’s Quant rates MFC as a Strong Buy with a near-perfect score of 4.98, with A/A+ for Valuation and Profitability.

Notably, MFC also trades at a discount compared to its Canadian peer Sun Life (SLF) with a price-to-book value of just 1.2x, comparing favorably to SLF’s 1.9x. MFC’s P/B also sits below that of American peers Prudential (PRU) and MetLife (MET), which carry P/Book ratios of 1.5x and 2.0x, respectively.

While some of MFC’s discount to its peers may be warranted considering that it scores a ‘C’ Grade for Growth compared to A and B- for SLF and MET (as shown below), I believe the market is not yet appropriately valuing MFC for its growth momentum in Asia and in its global wealth management business. Plus, MFC’s ‘A’ credit rating from S&P is more or less on par with the A+ of SLF, A of Prudential, and A- of MetLife.

Investor Takeaway

Overall, Manulife is delivering strong growth and profitability, with a focus on digitalization and expanding its presence in Asia, as well as inflows in its wealth management business. It also has a solid balance sheet and attractive capital returns through dividends and share buybacks. While there are risks to consider, the current undervaluation presents an opportunity for long-term investors to benefit from a respectable starting yield and future dividend growth and capital appreciation potential.

Compared to the last time I visited the stock in December 2022, I believe MFC is even more deserving of its aforementioned normal PE of 10.5, considering the higher interest rates in the current period versus where they were back then, and continued strong execution in the Asia and Wealth Management business. As such, I maintain a ‘Buy’ rating on MFC.